The Difference Between Good Money and Bad Money

It is said that the US dollar will eventually reach its intrinsic value, which
is zero. This is probably true, but the lack of intrinsic value isn't the main
problem facing the dollar and the other fiat currencies of the world. The fact
is that money never has any "intrinsic" value, even when the money is gold
and silver coin. To see that gold has no intrinsic value, imagine that you
are stranded alone on an island with no hope of ever being rescued and consider
how much an ounce of gold would be worth to you in that situation. In such
a situation you would, in all likelihood, value an ounce of coconut or an ounce
of fresh fish far more highly than an ounce of gold.

The value of money is always subjective to the extent that it depends on the
preferences/circumstances of individuals, although at any given time the value
of the thing chosen as money -- chosen by the market in the case of a free
economy or chosen by the government in the case of a 'managed' economy -- can
be measured by what the money can buy. This value will fluctuate regardless
of the form the money happens to take, but over the long-term the fluctuations
in the value of GOOD money will even-out or have an upward bias (the money
will tend to increase in value over long periods of time) because the supply
of the money will be fairly stable. Not-so-good money, on the other hand, will
become less valuable over time due to an increase in its supply. The difference
in the long-term rate of change in supply is therefore the primary determinant
of whether one type of money will prove to be better, or worse, than another
type of money.

Further to the above, even though the dollar is just a piece of paper or a
number inside a computer with no physical form whatsoever, it would be a fine
currency IF its supply could not be increased. The main reason it and the other
fiat currencies of the world are not good forms of money is that their supplies
can be increased ad infinitum. And what's worse, their supplies can be increased
ad infinitum at virtually zero cost at the whims of governments and banks.

Given the ability to create new money "out of thin air", which can, in turn,
be used to buy votes, the average politician will succumb to the temptation
to create the money irrespective of the long-term effects of the resulting
inflation. In fact, for a politician to be successful it is almost a prerequisite
that he/she be prepared to make full use of the inflation tool to garner votes.
This will always be the case, which is why it is important that politicians
do NOT have this ability. Moreover, the only way to ensure that they don't
have this ability is to use money for which the supply is subject to a rigid
physical limitation. Gold and silver fulfill this requirement because they
are elements that can neither be created nor destroyed by humans. We can change
the location of the gold -- for example, by shifting it from below the ground
to above the ground -- but we can't create more of it. Furthermore, we can't
even shift the gold from below to above the ground without expending considerable
resources.

It was the use of gold as money that limited the spending and growth of the
US Government -- and protected the freedom of US citizens -- for many generations,
even during the 20-year period after the 1913 advent of the Fed. However, a
new political modus operandi was put into effect by President F.D. Roosevelt
during the 1930s, and due to its proven ability to achieve the primary goal
of electoral success (Roosevelt won 4 consecutive presidential elections) this
new method of politicking became the template used by both major US political
parties from then on. The following excerpts from John Flynn's book "The Roosevelt
Myth"(1) briefly describe this method, which although new for the US was an
age-old practice elsewhere:

"When first elected, Roosevelt naturally supposed that to spend he would
have to tax, which is very unpopular. The alternative would be to borrow
from the people and he knew that was difficult. He did not dream of the incredible
miracle of government BANK borrowing. He did not know that the bank lends
money which it actually creates in the act of making the loan. When Roosevelt
realized this, he saw he had something very handy in his tool kit. He could
spend without taxing people or borrowing from them, while at the same time
creating billions in bank deposits. Wonderful!"

And: "Roosevelt discovered what the Italian Premier Giolitti had discovered
over 50 years before, that it was not necessary to buy the politicians. He
bought their constituents with borrowed money and the politicians had to
go along. Everybody with a halfway appealing tale got money, but on one condition
-- that he play ball with Roosevelt."

And: "With the rise of the New Deal...a vast army of persons appeared on
the payroll of the federal government and because some of the payrolls were
flexible and had no connection whatever with the Civil Service, it was a
simple matter for the government to use the ancient but now enormously enhanced
tool to control votes in particular localities. Benefits paid to farmers,
subsidies of all kinds could be timed in their delivery to correspond with
the moment when farmers were making up their minds how to vote. Relief rolls
could be expanded in doubtful counties and doubtful districts, and this was
done..."

Of course, before he could fully implement his grandiose borrowing/spending
plans Roosevelt had to renege on the government's commitment to exchange dollars
for gold at a fixed rate and he had to prevent US citizens from accumulating
gold (which many of them naturally would have done in order to protect themselves
from the inevitable consequences of the inflation).

Economically, Roosevelt's massive government borrowing/spending scheme --
the same sort of 'solution' that many people are advocating today -- was a
total flop, for the reasons that anyone with even a basic understanding of
economics would appreciate. For example, during Roosevelt's first 6 years in
office the Federal Government's debt ballooned astronomically in response to
government spending on an unprecedented scale, and yet the number of unemployed
in America was higher in 1938 than it had been when Roosevelt was first elected
President in 1932. The grandiose spending was, however, a political success,
and thus fulfilled its primary objective.

The bottom line is that today's US dollar and its fiat currency brethren are
not good currencies and will ultimately lose most, or all, of their value,
not because they have no intrinsic value but because their supplies can be
increased ad infinitum at virtually no cost. Politicians can't resist the temptation
to pander to voters using the 'miracle' of inflation, and, of course, it helps
that the average person doesn't yet know or care about the long-term effects
of the various spending plans. It also helps that well-respected analysts are
calling for the government to spend aggressively to fight the economic downturn.

(1) Although this book was first published 60 years ago it
is very relevant today, due to the parallels between 2007-2008 and 1937-1938
and due to the clamouring for a "New Deal" type of solution to the current
economic malaise. John Flynn was an excellent writer who closely followed
the political and economic developments during the four Roosevelt Administrations.
The book can be purchased from the store at www.mises.org.